It took just seven days for almost everyone in economics to agree
that negative interest rates are a failure: They have not
achieved their goal of flushing cash out of the banking system to
fuel inflation and growth through cheap credit.

That lesson will be difficult for conservatives to swallow. It
was the right — Thatcher and Reagan, specifically — who convinced
us all back in the 1980s that conducting economics via central
bank monetary policy and not through fiscal government spending
was the correct course.

Now, with the negative interest rate experiment in tatters, it
will be interesting to see if the Keynesians on the left can use
this as a political victory to push for the kind of
government-backed fiscal solutions that are beyond the powers of
central banks.

First, let's examine why negative interest rates have been such a
failure, and then we'll turn to the political repercussions for
the conservatives who are to blame for them.

"Very costly for the national economy."

On February 11, seven days ago, the
Swedish central bank cut its interest rates more deeply into
negative territory, and said it would cut further if need be.
"There is still scope to cut the repo rate further," the Riksbank
threatened, while simultaneously acknowledging that its
ever-cheaper credit was blowing up the housing market in Sweden,
and that "such a development could ultimately be very costly for
the national economy."

Goldman Sachs' Japan
team thinks the negative rate there will have the
opposite of the intended effect: "We believe the stimulatory
impact on capex will be very limited in Japan, and the negative
rate could even have a negative impact on spending," they told
investors today.

Credit
Suisse'sHelen Haworth and her team
says negative rate expenses hurt bank profits, making them
loathe to extend credit, thus exacerbating the problem they're
intended to fix: "lending growth remains very low, and we think
that margin pressure is just one part of the problem,"
according to CS today.

David Bloom of
HSBC said, "Policymakers have been disappointed. The
simple fact is that negative rates have not prompted any
lasting weakness in currencies."

Malcolm Barr and his
team at JPMorgan published a paper this week that says
the effect of negative rates thus far has been so muted that
banks ought to push them as low as -4.5%, an insanely low
level. "Calibrations based on Swiss experience suggest that
with modest changes to the reserve regime, the policy rate in
the Euro area could, in principle, go as low as -4.5%," the
JPMorgan paper says.

(That last one is a weird policy idea: when it doesn't work, do
more of it.)

"Not sustainable."

It isn't working because even though central banks are charging
negative interest to commercial banks for storing cash, those
commercial banks are refusing to pass on the charges to their
customers. So the customers face no penalty for storing their
cash and doing nothing with it. At the same time, banks that face
negative interest rate exposure can avoid it by simply shifting
their cash into anything that isn't negative — bonds, foreign
currencies, whatever.

It's mostly Milton Friedman's fault.

People forget that the reason we're in this pickle — with half a
dozen central banks suddenly out of weapons just as China
looks like really wobbly — is because of an argument that
conservatives won in the 1980s.

Prior to the election of Margaret Thatcher in the UK and Ronald
Reagan in the US, the economic debate between left and right
centred almost entirely on fiscal policy. The left favoured
government spending and wealth redistribution to make society
more fair; the right favoured a reduction in both of those in
order to keep government finances both balanced and small.

It
would actually be really interesting to hear what Milton Friedman
would have to say about negative interest rates right
now.AP Photo/Eddie
Adams

Then Milton Friedman and monetarism came along. This conservative
school of thought argued that fiscal spending was much less
important than central bank policy.

A central bank could spur growth and inflation by lowering
interest rates and making cash cheap to borrow. The free market
would then decide the most efficient way to deploy that capital.
Economic policy need not rely on large government budgets to
function.

Over the next two decades, monetarism seemed to work really well.
The 1990s in particular were a decade of peace and prosperity for
the West.

Sure, there were two big market crashes in 2000 and 2007, when
the dot-com and property bubbles collapsed. But the monetarists
said those could have been avoided if central banks had been more
sophisticated, and quicker to increase rates in order to snuff
out those bubbles. Economics was reduced to an argument over
monetarist timing and technique, rather than the larger principle
of who exactly should be in control of capitalism — a bank or a
government.

The power of monetary policy is that it works really well if
interest or inflation is at 5%, for instance. You've got 500
basis points to play with, if you want to spur more growth; and
even more above if you want to crush inflation. Once you get down
to zero interest and zero inflation — where we are now — you're
screwed. No more basis points to lower, no more weapons. You're
sitting in a car with an empty tank, miles from the nearest
petrol station.

The obvious answer is to do it the old-fashioned way: fiscal
stimulus from governments, in the form of government borrowing
for spending on infrastructure. Railways, bridges, schools,
hospitals, universities. All the things the free market is lousy
at but that society needs anyway. All the things that provide the
stable, civilised underpinning that a free market needs to
function smoothly. And all that borrowing of new central bank
cash might fuel a little inflation along the way. (The
Chinese are trying that right now, in fact.)

It all depends on the quality of your government
spending, of course. If a European government ramped up its debt
to go war against Australia it would have a very different
economic effect than if that debt were used to build new
high-speed rail system. (Or a "garden
bridge.")

That issue — quality — has always been the left's weak spot in
economics, of course.

But with conservatives on the ropes due to monetary policy
failures, there has never been a better opening for an
anti-monetarist resurgence.